Tag: risk

The Risk Factor – Buying Index v/s Equity

On 16/03/1980, Joe the baker and Jack the carpenter invested in the stock market. Jack bought S&P 500 Index. Joe, on the other hand, thought that index investment is boring, and buying diversified equity instead would give better results, so he bought the stocks.

There is a prevalent notion that Index funds are static and boring. True, they don’t fall prey to sentiment movements and behavioural biases, but they are far from being static. Let’s look at S&P 500. On an average, 22 stocks in the S&P 500 are replaced every year. Stocks may be deleted due to reasons like Mergers and Acquisitions, or change of Headquarters outside of U.S, or if the stock is viewed as a “problem stock” – ie, the stock is not financially viable. Since 1980, over 320 companies were deleted from S&P as ‘problem stocks’.

16th Mar
So, what happens to our friend Joe the baker’s investment today, is that, at least more than half of the stocks he had bought, are not in the Index anymore. Also, a large number of his investments have either turned to losses, or performed substantially lower than the index.More than half the companies which were a part of S&P 500 in 1999, are no more included in it today. This means, that the makeup of indexes like S&P 500 are constantly evolving.

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When Everything Goes Right, It’s Too Late To Invest

There are those quintessential “happy” days the stock market sees, sometimes – stable Dollar, positive economic indicators, bullish stocks stay on course, previously bearish stocks don’t fall as much. This, certainly, doesn’t happen often but every now and then there are such days – the worst of days to start investing! “You have to buy when others are panicking,” said Jim Cramer of Mad Money, recently.

When it all goes right, stock prices saturate faster, there are fewer undervalued stocks in the short/medium term and most trading peers feel that the market Is going to self-correct soon.

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